4
reasons why this may be the worst crisis since the 1930s - and 4 projections
for what's going to happen
The Casey Report Webinar - Casey Research
I
identify the foundational forces now driving our economy to establish a basis
for the investment recommendations you'll read in this advisory in the months
to come.
The
role of the U.S. as the world's dominant economic superpower is now
challenged by an out-of-control growth in debt and a deterioration in its
reputation as a financial haven. The dollar is losing its special status as
the global "reserve currency," is leading, in turn, to higher
inflation, higher interest rates, weakening financial assets (stocks and
bonds) and runaway prices for commodities.
Let
the data and let them speak for themselves, with some interpretation along
the way:
1.
U.S. Government Deficits: From Bad to Worse
Government
deficits are the root source of the creation of money... and its eventual
debasement. Simply, when the federal government spends more than it raises in
taxes, it eventually has to create more money (in complicity with the Fed) in
order to pay the bills.
Of
course, it can borrow the money, but that often includes borrowing newly
created money from the Fed. The deficits remain and they accumulate and in
time. They must be resolved, either by payment or default, either overtly or
covertly through the mechanism of inflation.
While
some level of government deficits may be acceptable over modest periods of
time, the U.S. deficit is now well past the point of being acceptable. The
deficit will soon grow to monster proportions as the baby boomer retirement
obligations exceed the ability to tax the declining number of workers
contributing to the Social Security and Medicare funds.
Projections
of the likely deficit compared to GDP growth make it clear that the
government is faced with hard choices. The easy path of just letting the
dollar fall is the most likely.
2. The
Expanding U.S. Trade Deficit
It is
consumers who primarily receive the money provided by U.S. government
deficits. In this globally interconnected world, they then spend a portion of
that money on foreign goods. An unintended consequence of the ballooning
government deficits, therefore, is a large and growing trade deficit.
The
foreign recipients of those dollars - whether Chinese manufacturers or Middle
Eastern oil sheiks - have, in recent years, turned around and reinvested
those dollars in U.S. Treasuries. They have done so because of the perceived
safety of those instruments, and because of the sheer volume of the dollars
they have to invest. In addition, it has been in their commercial interest to
help finance the U.S. deficit.
With
the trade deficit now running at $750 billion per year, and much of that
money coming back into U.S. Treasuries, the U.S. government has grown
dependent on foreigners to sustain the continuing deficits.
That
level of debt would normally cause extreme weakness in a currency - just as
it would in the value of debt owed by a deeply indebted individual. However, the
sheer magnitude of the foreign holdings provides something of a bastion
against a total collapse in the dollar.
Even
so, some foreign holders are easing toward the exits... through the purchase
of an operating company or resource deposit here, or a landmark New York
building there. They might make a billion-dollar equity investment in a brand
name company, or exchange some dollars for a basket of currencies or a ton or
two of gold. It's a delicate balancing act, because if they get too
aggressive, they risk triggering a mad dash for the exits, a nightmare
scenario where the value of their trillions of dollars in holdings would be
devastated almost overnight.
3.
Rising Oil Prices Affect... Everything
The
growing global demand for oil, coming as it is against a backdrop of limits
being hit in production growth, is a major contributor to today's big price
rises.
The
clear and present danger is that we are now using several times more oil than
we are discovering. The world currently produces about 310 billion barrels of
oil per decade. That amounts to about three times the current discovery
rate of 100 billion barrels per decade.
According
to the Peak Oil calculations, we have already used about half of the energy
stored over the last 100 million years. Against that, we have a steady
increase in demand emanating from population growth and economic development,
especially in Asia. This, coupled with the dearth of major new discoveries,
assures that energy markets will remain at high prices, for the foreseeable future.
The current big drop from almost $150 to $110 has happened from a slowing
economy and from some conservation at the extreme high gas pump prices, but
the long term view is that the lack of reasonable alternative to petroleum
argues for continued higher prices returning to the previous peak in the year
ahead.
As
energy is a component in the manufacture of all goods and services, this is
of no small consequence. Energy has been the basis of the abundance of our
current existence and has allowed human population to grow from 1.5
billion to 6 billion over the last century.
4. War
Affects the Deficits and Hurts the Dollar
The
war in the Middle East adds unwanted pressure on oil and ratchets up
government spending. Less obvious is the damage to U.S. prestige that is
important in the ability of the U.S. to attract much-needed foreign
investment.
The
Congressional Budget Office estimates the war will cost 3 to 4 trillion
dollars, an amount of sufficient size that it will affect the U.S. financial
system.
Regardless
of the short term political ups and downs or even a new administration, the
pressures from war for big deficits and for dollar depreciation are
inescapable.
Where
Is the Economy Going in the Next Six Months?
Projections
1. The
housing decline is not yet done, because we will need another year to unwind
foreclosures in the pipeline. The housing bubble still has another 10% to 20%
to go to fully deflate.
2.
Consumers in the U.S. are not able to expand credit and are increasingly
concerned about the outlook for the economy, so they will slow spending both
at home and on imports, which means we are in a recession or about to confirm
one.
3. The
financial/banking system is weaker than understood. The global system and
literally trillions of dollars in derivatives has left the world's banks
teetering on the edge. Don't jump back into financials.
4. A
slowing economy - recession - coupled with inflation, creates a condition
referred to as stagflation, as the simulative bailouts compete with the debt
implosion of overleveraged financial institutions and real estate, to leave
us with stagnation and still high costs.
The
result of this is that the inflation rate, interest rate, food, energy and
precious metals are heading higher as the dollar is debased.
Higher
rates are not good for housing and stocks.
Finally,
it is important to recognize that the world remains in the throes of a deep
and serious crisis. While many analysts will express the view that the worst
is over or that, after a modest downturn, things will bounce back just like
they always have, our view is that what we will actually witness going
forward is a fairly steady erosion of paper currency purchasing power and
sluggish economic growth. The crisis will accelerate, moving faster, even,
than in previous major shifts such as that witnessed in the 1970s.
While
history may find we are too pessimistic at this point in time, in our view it
is far better to prepare for a worsening crisis and hope that it does not
materialize, than to expect business as usual.
Bud Conrad
www.caseyresearch.com
Bud Conrad is the chief
economist of Casey Research, LLC. and a contributor to the Casey Energy Speculator (CES), a monthly newsletter dedicated to uncovering deeply
undervalued investment opportunities in oil, natural gas, uranium and
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